Currently under discussion in bills pending in the U.S. House and Senate is the topic of bankruptcy reform as it pertains to the forced modification of mortgage loans by bankruptcy courts (commonly referred to as cramdown). While I strongly support an individual’s right to seek bankruptcy protection when there is no other solution available, I am hard pressed to accept or support blanket authority being granted to the courts to modify all loans secured by an individual’s primary residence regardless of the circumstances at the time of origination.

Credit unions and community banks have engaged in prudent and responsible mortgage lending and have results that reflect that disciplined approach. Yet, an unrestricted authority granted to the courts would allow these loans to be modified without our input in the same manner as those loans that were originated under subprime or other creative circumstances. Moreover, we work with members and customers on a case by case basis to make modifications where practical and assist homeowners who have had a significant economic event that has placed their residence in peril. We do not need a cramdown bill to show us how to work with our long term borrowers.

The blanket provisions of the current legislation would affect all types of mortgage loans and lines of credit and impact lenders across the board. Aside from the obvious financial burden that this would cause for banks and credit unions, there is the potential for a significant long-term impact that moves in the completely opposite direction from the intent of the bills’ sponsors.

If financial institutions and their investors could no longer rely on the terms and conditions of the notes and mortgages signed at the time of origination, there would be a further decrease in the appetite of these individuals to make or hold such instruments. The result would be an increase in the cost of mortgage credit as well as a decrease in the availability thereof. This is obviously not a proper solution for the problems that we currently face.

Reversing Course

Recent changes to the bankruptcy laws were much appreciated by the lending community as they eliminated many of the prior abuses that were utilized by individuals who had learned to operate within the letter, but certainly not the original spirit, of the law. This potential change opens a new door to bankruptcy abuse.

Stories are told across the country of individuals who are abandoning their house not because of an inability to afford the payments but because their economic analysis is that the value of the house has declined to the point where it is no longer a worthy investment. Borrowers in this category would become prime candidates to use a revised bankruptcy code to their advantage. Again, this is clearly not the intent of the lawmakers but a virtually certain by-product nonetheless.

Finally, I do agree with the ability of those who have become victims of the subprime process to seek reasonable and affordable remedies to their situation. Cancelation of prepayment penalties, modifications of interest rates to current market levels and even reductions of the principal value to a true-market level should all be in play if the original loan was granted as a sub-prime instrument or under any type of misleading circumstances.

To all community bankers, I urge continued efforts at finding reasonable accommodations for truly deserving borrowers while simultaneously maintaining vigilance on this topic. It is too important to ignore. â–